Hedging with Treasuries

April 12, 2007

Many thanks to Accrued for this excellent review of why bond fund managers – “real money” in dealer jargon – trade so much. Very illuminating, especially since I work for a Euro govy (EGB) dealer. I particularly enjoyed the explanation at the end of the use of credit spread trading to lock in profits, whatever happens in the Treasury market. It reminded me of some figures that I saw in Avinash Persaud‘s paper on the recently much discussed MTS “monopoly”. Table 2 in that paper shows daily turnover in govies by country for March 2006. Euro zone countries have turnover ranging from 1.2% of outstanding daily (FR,DE) to 10.7% (IT) and 13.3% (PT). The US daily turnover was 138.9%. I was initially startled by that figure til I remembered someone mentioning to me how heavily Treasuries are used for hedging in US markets. So thanks to Accrued for giving such a great example of that hedging.

In the Euro markets, if a trader wants to hedge against EGB price movement, he takes the opposite position in the relevant EurexFutures contracts – Schatz (2Y), Bobl (5Y), Bund (10Y) or Buxl (30Y). The contracts are highly liquid, net supply isn’t constrained, and capital requirements are low: it’s a contract, not a cash instrument, so a trader only needs to post margin on big moves.

By contrast, using cash govt bonds to hedge must tie up a lot of capital. I’m guessing there’s no Treasury futures market that would support cheaper hedging. If so, why not ? Shouldn’t CME be doing this ?